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Pessimistic Forecast From Economic Think-Tank

Analysis

The Hungarian economy will shrink by 0.5% this year, according to the latest forecast by economic think-tank GKI, giving a much worse prediction than the government’s expectation of a 1.5% increase. However, it agrees inflation might drop to single digits by the end of the year.

In light of the latest macroeconomics data, economic think-tank GKI Gazdaságkutató (Economic Research Company) has published a rather pessimistic forecast for the Hungarian economy. The institute still expects this year’s GDP to fall by 0.5% (as stated in its March forecast), and the danger of an even more significant decline can only be prevented by the faster-than-forecasted expansion of agriculture.

GKI analysts recall that the recession continued in the first quarter of 2023 (for the third quarter in a row), was down by 0.2% compared to the previous quarter, and there was even a decline (by 0.9%) when compared to the same period of the last year. In the first four months, industrial production was down by 3.2%, construction by 7.7%, and retail turnover by 10.4% compared to a year earlier.

The document states that business expectations do not point to a quick recovery. In June, the service providers’ confidence index fell to +5, the industrial confidence index to +7, and the construction industry and the commercial sector hit 38-month lows.

However, after last year’s significant drought-assisted decline, agricultural GDP might expand faster than previously expected.

As for Hungary’s industrial sector, GKI no longer expects growth this year; what’s more, it even considers a slight decrease a possibility. It also raised the anticipated rate of decline in the construction industry and retail trade to 10% and 4%, respectively. However, modest growth is likely in several of the service sectors; for example, finance, transport, tourism, and telecoms. Employment is expected to rise slightly this year, and the unemployment rate will increase only moderately from last year’s 3.6% to 3.9%.

Decreasing Consumption

GKI reduced the expected decline in consumption this year from 3% to 2.5%, as the volume of benefits in kind increased by a surprising 4.7% in the first quarter, the forecast reveals. However, GKI expects a 3.5% decline in the case of purchased consumption.

The think-tank finds the amended 2023 budget “unrealistic.” In its explanation, it emphasizes that in the first four months of 2023, the cash flow deficit of the general government exceeded 80% of the annual target by the end of May (it stood at 81.3%). The explanation for this lies, on the one hand, in the overly optimistic growth forecast, such as an increase in consumption. The other reason is probably the lack of anticipated EU transfers.

While under-planned inflation has a positive effect on budget revenues (at least in the short term), it is a source of additional tensions and risks on the expenditure side. The rise in debt ratio is particularly worrying.

According to GKI, in the presence of significant uncertainty – depending on the arrival of EU transfers and the expenses paid in advance – without measures to improve the balance, the deficit could be 1.5% higher than planned in the budget.

The economic research company assumes that the government will handle about half of this excess deficit through adjustments and the other half in the form of waivers. In other words, the think-tank expects a deficit of around 4.7% compared to the government’s projected 3.9%. The reduction of the national debt in proportion to GDP will be helped by inflation in 2023, so it is possible to reduce the debt ratio to around 69%, GKI says.

Single-digit Inflation

Price increases of around 19% are expected throughout the year. The high pace is partly the result of lingering effects. For example, energy prices will raise this year’s price level until September and fuel prices until December. At the same time, the run-out of this base effect predicts a rapid price drop compared to the same period of the previous year. The biggest obstacle to further monthly price increases is the decrease in purchasing power, the document states.

All in all, a single-digit price increase might be achieved by the end of the year. However, a combination of core inflation being higher than the increase in consumer prices, the expected rise in energy prices, the problematic situation of the budget, the elimination of price caps, the possible acceleration of wage growth, and, last but not least, the possibility of a significant weakening of the forint, could put the brakes on and slow or even prevent this from being achieved, GKI warns.

As for monetary policy, GKI expects that if the 100-point monthly interest rate reduction that has begun weakens the euro-forint exchange rate to more than HUF 400, it cannot be continued without interruption. The currently widespread opinion that the benchmark interest rate may drop to 13% as early as September (and would thus once again be the same as the base interest rate) may be too optimistic, GKI says.

However, during the fall or early winter, convergence could actually occur. In a favorable case, if inflation and especially the exchange rate make this possible, the reduction of the base interest rate might even begin this year, to about 12%.

At the same time, a severe weakening of the forint (for example, in the event of excessive speed in the interest rate reduction or the interruption of the EU negotiations) could halt the interest rate reduction process and, in extreme cases, even lead to further tightening.

This article was first published in the Budapest Business Journal print issue of June 30, 2023.

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